Securities and Exchange Commission v. Retail Pro

The opinion of the court was delivered by: William Q. Hayes United States District Judge

ORDER

HAYES, Judge

The matter before the Court is the Motion for Reconsideration of Portions of Order Dated November 18, 2009 ("Motion for Reconsideration"), filed by Defendant Ran H. Furman. (Doc. # 50).

I. Background

On September 4, 2008, Plaintiff Securities and Exchange Commission ("SEC") initiated this action by filing a Complaint in this Court. (Doc. # 1). The Complaint alleges:

3. This case involves a fraudulent scheme by Island Pacific, Inc. ('Island Pacific' or the 'Company') and its then senior management to overstate the Company's financial results for the quarters ended September 20, 2003 ('Q2 2004'), and December 31, 2003 ('Q3 2004'), and its fiscal year ended March 31, 2004 ('FY 2004'). The Company's senior management responsible for the fraud were defendants Barry M. Schechter ..., a controlling person and de facto officer; Ran H. Furman ..., the Chief Financial Officer; and Harvey Braun ..., the Chief Executive Officer.

4. In Q2 2004, Schechter, Furman and Braun caused Island Pacific to improperly record and report $3.9 million in revenue from a sham transaction with an Australian software company, QQQ Systems Pty Limited ('QQQ'). The transaction had no economic substance or business purpose and instead was entered into in order to artificially inflate Island Pacific's revenues reported in its financial statements. Subsequently, in the third quarter, Island Pacific improperly recorded an offsetting transaction whereby it purchased from QQQ $3.9 million of software. In fact, no contract finalizing this offsetting transaction was signed until the fourth quarter. Island Pacific and QQQ never exchanged any money as a result of these offsetting agreements. In addition, neither Island Pacific nor QQQ made any effort to sell the other's software or to determine the fair market value of their software licensing rights as required by applicable accounting principles.

5. As a result of improperly recognizing and reporting the $3.9 million as revenue, Island Pacific overstated its revenues by 140% for Q2 2004, 29% for the nine months ending Q3 2004, and 22% for the 2004 fiscal year, and reported a small profit instead of a massive loss for Q2 2004. The defendants also failed to disclose the sham nature of the QQQ transaction and actively concealed their fraud from Island Pacific's outside auditors, and the public, by creating forged and/or fabricated documents which they used in an attempt to demonstrate that the recognition of revenue from the transaction was proper. Additionally, Furman fired a company whistleblower [i.e., Joseph Dietzler] who expressed concern in an email that the offsetting transactions were 'structured in a manner that is intended to inflate revenues for the purpose of boosting the corporation's share price.'

6. As part of the fraudulent scheme, Schechter sold 637,750 shares of Island Pacific stock, receiving $488,410 in ill-gotten gains.

7. By engaging in this conduct, the defendants variously violated and aided and abetted violations of the antifraud, issuer reporting and record-keeping, internal controls, and prohibition against misrepresentations to accountants provisions of the federal securities laws. The Commission seeks to obtain injunctions from future violations, civil penalties, and officer and director bars against Schechter, Furman, and Braun, and additionally to obtain disgorgement of ill-gotten gains from Schechter. (Doc. # 1 ¶¶ 3-7). The Complaint alleges the following claims against Furman: (1) fraud in connection with the purchase or sale of securities pursuant to 15 U.S.C. § 78j(b); (2) record-keeping violations pursuant to 15 U.S.C. § 78m(b)(2)(A) and related regulations; (3) misrepresentations to accountants pursuant to 17 C.F.R. § 240.13b2-2; (4) internal control violations pursuant to 15 U.S.C. § 78m(b)(2)(B) and related regulations; and (5) false certification violations pursuant to 17 C.F.R. § 240.13a-14.

On August 10, 2009, the SEC filed a Motion for Summary Judgment against Furman, the sole remaining Defendant. (Doc. # 33).

On November 18, 2009, the Court issued an Order granting in part and denying in part the SEC's Motion for Summary Judgment. (Doc. # 47). The Court ordered: "The SEC's Motion for Summary Judgment is GRANTED as to the following claims against Furman: Section 13(b)(5), Rule 13b2-1, and Rule 13b2-2. The SEC's Motion for Summary Judgment is DENIED as to the following claims against Furman: Section 10(b), Rule 10b-5, Section 20(e), and Rule 13a-14." (Doc. # 47 at 45). In the Order, the Court addressed evidence of a February 4, 2004 email sent by Joseph Dietzler, who was then Island Pacific's Contract Administrator. The email, which was sent to Furman and others at Island Pacific, stated:

I have continuing concern[] that certain transactions involving the company QQQ appear to be structured in a manner that is intended to inflate revenues for the purpose of boosting the corporation's share price. The 'sale' to QQQ under the agreement entered into in late September 2003 creates such an appearance for the following reasons:

* Substantial up-front fee for a distribution license, rather than a royalty stream

* Revenue from the transaction comprises approximately 50% of entire quarter's revenue

* Entered into at the close of a quarter in which revenues would have been far short of estimates, if not for the single transaction with QQQ

* Extended payment terms were granted

* To date, no payments have been received and are well past due Under another transaction, QQQ is selling product ownership and distribution rights to Island Pacific, and QQQ is to be compensated, in part, through debt forgiveness in amount roughly equal to the amount of the uncollected revenue that was recognized from the September sale to QQQ. Irrespective of the legitimacy of the foregoing transactions, the totality of the surrounding circumstances creates the appearance that the transactions were intended merely to boost the reportable revenue of Island Pacific in the quarter ended September 2003. Further, the timing of the second QQQ transaction is in fact in the current quarter, not the quarter ended December 31, 2003. While the second transaction is not revenue, it must be reported in the current quarter (ending March 31, 2004), as it substantially impacts the corporation's receivables.

To ensure compliance with financial reporting rules, it would seem prudent that revenue recognition policies err on the conservative side, so as to avoid even the appearance of irregularity. Such practices will help ensure that the activities of the company do not precipitate potential allegations of improper accounting. I believe the transactions involving QQQ should be restructured in a manner that makes each entirely independent of the other. As payment has not [been] received for the September 2003 sale, that situation should be dealt with in accordance with routine accounting standards. I recommend that these transactions be given careful ...

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